How to sack your IT supplier

Clients often come to us asking how they can get rid of their IT supplier. Their reasons are many, and vary from performance-related concerns to wanting to reduce costs by deferring or going without the services. This has especially been the case during the recent economic downturn.

Of course, the problem with a contract for the supply of IT solutions is that it is just that — a contract. It means that, unless you have a right to get out of the contract, you are contractually bound to honour it until it expires. If you make the mistake of behaving as though you are not bound by a contract, you risk repudiating it — a legal concept which allows the other party to terminate the contract and sue you for the loss of it. In an IT supply sense, that usually means the profit the supplier would have made over the term should the contract have been performed, which could be substantial.

Terminate for convenience

There is a similar risk if you attempt to formally terminate a contract in circumstances in which you did not have a right to do so. I have had some clients simply write to their supplier and inform them in no uncertain terms that they are terminating their relationship with three months notice. There is no inherent right in IT or other contracts to do this. If you wish to have the right to terminate an agreement whenever you like, for any reason, you should ask that such a right be inserted into the contract when it is being negotiated. It is known as a right to terminate for convenience. Suppliers will often ask for a fee to be associated with the exercise of such a right. Whether or not you grant one will depend on the circumstances and your skill as a negotiator, but many recipients of services always like to have the option to terminate even if it means they have to pay a fee. At least the exit cost will be known, and with any luck the only legal fees you will have to pay will be in relation to the drafting of the termination notice.

Implied rights

If you did not expressly agree to a right to terminate for convenience, it is possible that one will be implied — in which case you will be able to terminate on reasonable notice. This is more likely to have occurred if you do not have a written agreement with your supplier. What constitutes reasonable notice will depend on all the circumstances, and may be difficult to pin down. Any expenditure by the supplier in relation to the service being provided will be relevant, as well as the period over which the services have been provided and the supplier’s ability to find other clients. Practically, the notice periods tend to be between three and 12 months, but this is not always the case. If you attempt to terminate and give notice which is shorter than what a court considers to be reasonable, the supplier may keep the agreement on foot or terminate it and you may be liable for the profit the supplier would have made had the notice period given actually been a reasonable one.

Poor performance

Depending on the terms of the agreement with the supplier and the manner in which they have performed, you may also have a right to sack your supplier for poor performance. It is known as termination for cause. The supplier must have breached the terms of the agreement in a sufficiently serious manner — this may be a right under the general or common law, or it may be a right pursuant to the terms of the contract. Either way, you should seek support from your lawyers to manage the process and to advise on whether or not the breach gave rise to a general law right of termination or fell within the terms of the contract that allow you to terminate in particular circumstances.

Negotiating rights

It is in your interest to make the right to terminate for cause as broad as possible when you negotiate. The broadest right is the ability to terminate on any breach of the contract. Suppliers will try and narrow the right through referral to a ‘material breach’ or a breach of a ‘material clause’ that has a ‘material adverse effect’ on you.

Arguments can be had as to what these phrases mean, but the downside to you as the customer is that each additional concept becomes another hoop you have to jump through to establish that the termination right has arisen. It is a good reason to resist these qualifications as much as possible.

Another common supplier request is to have an opportunity to ‘remedy’ a breach before a right of termination comes into effect, which generally means the supplier can have another go at performance. This procedure will have to be followed in order for your termination to be valid. Generally, it is not unreasonable to have this concept in a contract, but you should consider whether you want the ability to terminate on any breach of particular clauses such as those relating to security, intellectual property or confidential information.

One thing to keep in mind when a right to terminate for cause arises is that it will be lost if you continue to treat the contract as ongoing. This is known as ‘affirming’ the contract, and it is seen as an election to require the supplier to continue performing it rather than exercising your right to terminate. If you attempt to terminate a contract after you affirm it then the termination will not be effective, and you may be seen as repudiating the agreement and exposing yourself to a claim for damages flowing from wrongful termination.

Other considerations

The spectre of repudiation hangs over every termination, and you should always seek legal advice to reduce the risk of getting it wrong. It is not always a simple exercise, even for lawyers. Other factors courts consider in determining whether or not a termination is effective is estoppel (have you condoned the wrongful conduct?), the notice requirements of the contract (have they been sufficiently followed?), whether you have exercised the right in a reasonable time, and even whether or not the right has been exercised in good faith (did you really terminate the contract to get a better price with another provider?). Damages recoverable on termination is another consideration, as is whether or not transition services are required to be provided to you or an incoming supplier.

As always, life will be easier if you pay more attention to the terms of your contract when you negotiate, and do not just accept the termination clauses put forward by the supplier in their standard terms without due consideration.

David Downie is a partner in the intellectual property group of law firm McCullough Robertson.

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